Eleven seasoned executives debated the industry’s response to the 2017 cat losses and how the relationship between ILS and traditional reinsurers continues to mature and evolve, at the annual Bermuda:Re+ILS roundtable in association with Markel Reinsurance held at the Monte Carlo Rendez-Vous de Septembre.
- Brad Adderley, partner, Appleby
- Mark Berry, head of specialty, AXA XL (formerly of
- Paschal Brooks, chief operating officer, AlphaCat Capital
- Robert DeRose, senior director, AM Best
- Kathleen Faries, head of Bermuda, Tokio Millennium Re
- Peter Gadeke, executive vice president, Willis Re
- John Huff, chief executive, Association of Bermuda Insurers and Reinsurers
- Dan Malloy, chief executive, Third Point Reinsurance Company
- Jed Rhoads, president and chief underwriting officer, Markel Global Reinsurance
- Arthur Wightman, territory leader for PwC Bermuda
- Greg Wojciechowski, president and chief executive, Bermuda Stock Exchange
- Moderator: Wyn Jenkins, managing editor, Bermuda:Re+ILS
Let’s start with your reactions to Harvey, Irma and Maria, and some of the trends you’re seeing in the market.
Jed Rhoads: We had some excitement last year with hurricanes Harvey, Irma and Maria (HIM) and the California wildfires. The market had its head around handling HIM fairly well, but the California wildfires put a monkey-wrench into a lot of things—to have the worst-ever wildfires caught everyone a bit on the hop.
The great thing about the reinsurance industry is that it’s able to respond to these kind of events, and even a frequency of cat events, with great aplomb—you didn’t hear of claims not being paid. The industry was ready for it, it responded well, and Bermuda in particular was front and centre with a lot of these claims.
Lessons were learned: the California wildfires are continuing this year, and there are lots of weather conditions that mean they might be here for a while. Reinsurers are examining certain kinds of structures they wrote, such as aggregate covers that accumulate these kinds of risks. Buyers are going to reshape their programmes a bit, demand is probably going to go up, but supply still far outstrips demand, so I don’t think it’s going to have a massive impact on pricing. Pricing is probably going north, rather than south, so that’s good.
Is it commonly felt that Bermuda responded well to the events, and does this stand it in good stead?
John Huff: Yes, and the belief is not just from the Association of Bermuda Insurers & Reinsurers (ABIR)—it is also from the regulators, cedants and brokers. I come from a regulatory background, so the first thing I wanted to know when I took the position as ABIR president in January was where we were as a market in responding to HIM. I didn’t want to get into the middle of something where we weren’t moving as quickly as we ought to.
I made the rounds of the brokers, who assured me there were no issues with claim payments. I quickly learned that in the Bermuda market that’s part of the value proposition: we make sure there’s liquidity, and a rapid adjudication for cat events, and this is where we’ve earned the reputation of being the first in class on nat cats.
We’ve also learned that we need to diversify, and not have all our eggs in one basket, and that’s why you’re seeing so many companies in Bermuda take other types of risk, and not just be in the game of responding to nat cats.
Kathleen Faries: The two main questions for a lot of people were: how the insurance-linked securities (ILS) players were going to respond to the 2017 losses and how quickly the markets would reload. At TMR we observed that the ILS players responded very similarly to what we would see from any traditional player.
We received calls immediately following the catastrophes from our partners. Then, the reloading of the capital happened a lot more quickly than they thought it would. Claim payments were very orderly and the confidence level went up dramatically.
Dan Malloy: We were observers to the cat losses, given our cat exposures are very minimal, but the fourth quarter was active for us last year in that a number of reinsurance firms who enjoyed a decade of largely cat-free experience, diversified into other areas, and HIM caused retrenchment.
Reviewing a 105 percent combined ratio in a non-core business at a time when you’re re-underwriting your core business meant some pretty significant underwriting changes were made in a short period of time.
Primary insurance clients were grinding out low to mid-single digit rate increases, because they saw they needed to take the increase. We were generally pleased by the dividend we received in our non-cat business as people were gearing up for a much harder cat market.
Mark Berry: One thing I noticed from the traditional capital side, there was an acute awareness to the level of claims-paying service and to honour the promise to pay with our Insurance partners.
Where did that mentality came from? With the ILS in the market, did the traditional carriers want to be seen to be on the ball?
Berry: As we aim to differentiate ourselves in this market we have to move beyond the price point and the selling of the product upfront. That goes all the way through the spectrum, from claims paying ability, to innovation, to closing the insurance gap. These are the other things that ultimately define our companies.
Greg Wojciechowski: When we first started to support the ILS market over 10 years ago, the discussion was about whether the capital would stick around. The 2017 Atlantic hurricane season was a real test of the ILS markets’ ability to pay claims and attract new capital and was proof of the durability of ILS structures and the ‘sticky capital’ that supports them.
Bermuda has been at the forefront of the global boom in ILS investment and will continue to support the creation, listing and trading of securitised insurance-related structures. From the Bermuda Stock Exchange’s (BSX) perspective, we are the global leader in the listing of ILS, with now more than 80 percent of the global issuances listed on the Island.
For the market to use Bermuda as a commercial platform, and to see the investors in ILS reloading after last year’s hurricane season is a testament to the Island.
Moving forward, the ILS market in Bermuda is continuing to evolve. More structures are looking to diversify away from pure weather-related risks and now starting to include other risks, such as wildfires. These are interesting times.
Will the market look back on the 2017 losses and say ‘that was the moment everybody believed ILS was here to stay’?
Wojciechowski: That has happened already—I don’t think it was 2017, it started to happen several years ago. But I agree that 2017 was a pivotal moment.
Arthur Wightman: 2017 was an opportunity for the market to be tested, and that has helped to affirm the validity of that marketplace within the overall reinsurance value proposition. What you’ve seen subsequently, particularly with some discussion around the use of ILS far more extensively, and the M&A activity that’s been occurring, there’s a lot more validity behind securitisation as part of the proposition.
Huff: 2017 was a test for the entire market, with the first set of significant losses since the financial crisis for the industry, and by and large it was an earnings event, rather than a capital event.
Brad Adderley: We’re going to look back and see this is a fair-weather and honest market. Claims were paid so quickly, and there was no question of investors saying, ‘don’t pay up, I was here to make money’. They’ve paid up, and more money came in.
However, more money came in to the traditional ILS players who are already in the ILS market, but not many of the brand new startups have been successful in raising new capital.
It’s going to get harder because it’s a bit of a hard market, with single digit increases, and no-one’s getting that excited about the numbers. If you didn’t raise your capital in December last year, is it going to get worse?
Paschal Brooks: If you look at the leading ILS providers, the top 10 control about 70 percent of funds.
What’s the significance of that?
Robert DeRose: It’s the scale and relevance, the track record—you want to know who your counterparty is, and to make sure they’re going be there for the long-term, those are all important issues. Let’s face it, size sometimes dictates your dependability over the longer term.
Peter Gadeke: Going back to the HIM losses and the way the investors reacted, the types of losses were archetypes of what you say could happen to an investor. It may be easier to go back into the market and say, ‘we told you this could happen, within events this is a modelled loss’.
The wildfires are slightly different, that makes it trickier. If you’re an investor, you’ve been told this many times in investor presentations: ‘the market’s going to progress, it’s probably going to move on. We told you this could happen, now it’s happened’.
Brooks: In terms of the types of losses ILS investors prepared for, this is definitely in the range of expectations, a series of medium-sized US hurricane events. Because of that, loss estimation was better for the hurricanes than for the later wildfires. The modelling is relatively robust for hurricanes, and simulations can be run reasonably quickly thereafter. At the time, investors felt they had a reasonable understanding of the losses and were relatively quick in being prepared to recommit for 2018.
As you move into 2018 with capital-raising for 2019 ongoing, conversations between ILS managers and investors have focused on a benchmarking exercise. Investors are now trying to compare the reserve numbers that were put up at the end of 2017 with the actual experience. There is quite a bit of divergence though because the 2017 losses have actually turned out to be complex events.
A second concern is based on the fact that a lot of those commitments that came in at the end of 2017 were based on rate projections about what returns were going to be in 2018. As we all know, there was a big range of predictions in terms of what the rates would be, and generally speaking the actual rates have been in the middle to lower end of those predictions.
Rhoads: The ILS and the traditional market might in the future be seen not as two separate things, but as one market. It’s here to stay, and Markel has made an enormous bet in the ILS space. We’re proud of it, and we feel fortunate to be close to acquiring Nephila. We bought CATCo three years ago, this gives us a roughly 20 percent share in the ILS market with about $19 billion of AUM.
We’re going to come to a point where we’re not talking about ILS and traditional, we’re talking about how we deliver reinsurance capacity and capital to the market, in the most efficient fashion.
It’s easy to make the mistake of thinking that the reserving that equity carriers applied to their business is the exact same as that applied in the ILS world. It’s not, it’s a different lens, they operate under securities laws, they do not have the same obligations. People who confuse how an equity company reserves with how an ILS company reserves are making a big mistake.
If you’re running an ILS one, you get what’s reported to you, and you have an obligation to those investors not to go too high, or too low, based upon what you know at that time. An equity carrier can put up more, they can be more conservative, and that is part of the evolution of knowledge process that ILS carriers will go through, they will do their fundraising and as soon as events occur they will reload, and that has proved to be a relatively simple process.
Their obligations to investors to reserve are not the same as an equity carrier’s obligations to its shareholders, regulators, and rating agencies to reserve it.
DeRose: If you have a traditional carrier that’s using alternative capital for retro-focuses, if they’re conservative in their reserving assumptions—and they should be—then that ILS capital is going to attach. If there’s stable development in the ILS pot it will lead to that claim going forward, but nonetheless that collateral is tied up until there’s more certainty around the losses.
Rhoads: Some people have been critical of the ILS companies and how they reserve. How they reserve is how it’s been reported to them. People forget that, if this is what they reported, it’s not as though they’re undercutting what’s been reported to them, they’re actually putting up even more than that.
Huff: We’re seeing deterioration on some of the Irma claims, because there are issues in the US on assignment of benefit fraud in Florida. Some claims that were closed have now been reopened, and that’s not a minor issue—it’s an issue we need to fix with our advocacy work.
Berry: We have globalisation in multiple contexts, plus new age risks such as cyber, right through to global climate change issues. From the traditional side of the fence we have to focus on underwriting then we can corral the capital that’s coming in from other sources that are not traditional to what we’ve known as an equity company, and use that as an opportunity to face these challenges.
Rhoads: A lot of lessons were learned, but one of them is that I don’t think many carriers put their hands on their hearts and were honest with themselves as an industry. No-one thought that the allocated loss adjustment expense associated with Irma losses, and the assignment of benefits (AOB) issues would be approaching 20 percent.
People may have used 7 to 14 percent as a pricing metric, but I don’t think anyone was consistently using 20 percent on every single deal they quoted. If they did then they wouldn’t have written any business whatsoever.
Faries: You hear a lot about insurtech and how insurtech is evolving to be more about partnerships, but maybe we’ll start to see other successful models based on the combination of know-how, such as in the partnership of Nephila and Markel, or CATCo and Markel, or TMR working with asset managers; there are benefits and strengths on both sides. At TMR, we deploy our strength in working closely with ILS asset managers .
Malloy: Matching demand and supply and having a diverse supply of capital looking for different terms, is certainly something that the industry has been moving towards. The idea of transferring new risks from the public sector to the private sector is a revolution going on in the business right now.
Pressure on mortgage players to diversify their capital base has been great new business for the P&C industry. Here’s one area of the business where demand exceeds supply, given the amount of mortgage CRT business being transferred.
This counteracts the worst inclination in the reinsurance business: to compete away all the profit as soon as somebody sees a profitable opportunity. A limiting factor for us is when you’re subscribing you’re on the hook, you’re taking a view on the economic outlook of the global economy for the next 10 years.
DeRose: You have to understand the dynamics of that business and the risk you’re taking, its duration and the accumulation aspects. As long as you have that understanding, and the ability to control it and monitor it over time, fine.
Rhoads: One of the interesting things about ILS is that it is correlated relatively low to the rest of the financial markets. The mortgage liability business is correlated to the markets. If you go too long into that, you’re going to have a hard time getting it off your books if there is a need to.
Malloy: It struck me when you go to some of these conferences, there are thousands of people attending, and about 20 reinsurers there who are actually holding the risk; the other 1,980 people are busy figuring out how to collect their golden crumbs every time they trade. It’s all about trading: what’s the market price, what’s the volume, what’s the liquidity? You have a few reinsurers sitting here, saying, ‘we’re holding that risk’.
Are we going to see more deals like Markel-Nephila? Is that going to drive M&A?
DeRose: What they did makes sense. No-one can predict the future, but to me it seems as though it’s a natural part of the evolution process, especially for those smaller players. It might make more sense for them to find an enduring partner through common ownership.
Faries: Cost is an important factor in the equation. It’s obvious that margins are shrinking particularly for property cat, and it doesn’t look as though this trend is going to reverse, so we must respond. Managing expenses is going to be a theme for everybody, traditional players and ILS partners. This is why leveraging all that technology will have to offer in the coming years will also be important.
DeRose: Prices are probably not going to improve dramatically, unless there’s a $400 billion event. You have to find a way to improve the efficiency of your capital, your capacity, and this is one way to do it.
Rhoads: When we were going through the logic of this, we said, ‘what pieces of the puzzle do we need to be competitive going forward? What does the model for 2025 actually look like, to compete?’. We said, ‘well, we need a fronting carrier—OK let’s go out and buy State National’, and ‘we need an ILS carrier—OK, let’s buy CATCo’. We said, ‘we need an ILS carrier with broader depth rather than single product’.
Nephila happened to come along. We didn’t target it, but we thought when it came along that they were the pre-eminent original pioneer in this area.
If you put that together with the traditional re/insurer, those five components shouldn’t add up to five, it should add up to seven or eight. You start to truncate the value chain and say, we need to become a leaner operator, we need to deliver this capacity and capital to our clients in a more efficient way. We need to do that by any means possible, if we want to be relevant in 2025.
Gadeke: They are the biggest example of the ILS and investor platform trying to reach beyond the reinsurance market to get into the insurance space, and that’s why that Markel deal makes sense. On the convergence side, obviously everybody’s managing capital and risk using third-party capital. But it’s those who want to take the next step and say, ‘OK, I’ve got investors who want to get into the insurance market’. They’re further ahead, for some it’s perhaps a bit further out.
DeRose: The only way to harness opportunity is to have the ability to do almost everything. For those who are narrowly focused, there’s a set of opportunities there, but that set of opportunities is not going to expand. If you want to go beyond that, you probably have to make sure that you have a lot of tools in your toolbox.
Adderley: You need to have access to the risk, access to the business. On the M&A side if you’re a small player, you probably don’t have the same access, you won’t provide the same value to a cedant such as Markel to buy them, because you’re not big enough.
When we talk to some of our clients, they’re starting to think, ‘I have to start growing more third-party business, with more people I don’t know’, and that’s an expansion we’re seeing.
Huff: Our partnerships make us as an industry more meaningful, because we’re speaking with a single voice, and our advocacy is more effective.
Adderley: We were talking about the mortgage business earlier, Bermuda is putting up the pace and there’s been a great increase in life business. We see the life companies writing some of this mortgage business, which makes sense concerning the long-term nature of it, and shows the expansion of Bermuda more into the life insurance and reinsurance spaces.
Huff: We talk about mortgage and GSEs, but really that’s a
subset of a larger tremendous opportunity which is de-risking governments.
How can the industry deliver on that? Can Bermuda as a collective play a role in that?
Rhoads: It is already, quietly. When we think about flood, we tend to talk about the NFIP, but I’m aware of at least 10 or 15 other initiatives where the Bermuda market and the general market are nibbling around the edges of NFIP and the private market, that are very quiet smaller-bite deals.
There’s no reason why in the US we should be excluding flood, or not covering flood, the private market can actually handle probably all but about 15 percent of the flood risk in America.
All the European countries cover flood, it’s just that America has a historical system, but what you’ll see is unlike the mortgage business where the industry cannot take all that on, you will see it take on over the next 10 years a meaningful chunk of the flood exposures, taking it out of the government’s hands and into the private market, delivering it in a more efficient and cost-effective way to the consumer.
That will begin to happen with cyber and terrorism in a bigger way as well. There are limitations on the mortgage side given the correlations with the overall markets, and the sheer size of it.
Huff: The beauty of private flood is, all the studies show it’s a great win for consumers. A Milliman study shows that in Texas, Louisiana, Florida, north of 70 percent of our consumers will get a lower priced better product. In New York, New Jersey, over 90 percent of those policyholders will get a better deal.
Malloy: You have to unpeel those layers. Changing the status quo is hard, there are some people right now very happy with the existing system, and prying their hands off that monopoly is a challenge.
How does Bermuda persuade governments to start putting these risks to the private sector?
Rhoads: You do it a lot of different ways: through insurtech opportunities, through private carriers, through the pure maths, science, and underwriting that goes into flood. Flood is not a complicated risk, it’s a very measurable, identifiable, priceable risk in the US.
A minority of that risk is not priceable at any cost, or reasonable cost, and that probably should remain within the NFIP and become what the NFIP was originally set up to do.
Huff: We also do it through working with like-minded people around the world, we’re not necessarily pitching Bermuda all the time, we’re pitching ‘let the private sector solve an issue’, and then we can compete with whoever is in that private sector, whether it’s at the OECD or the Geneva Association, or Global Reinsurance Forum, or others.
Wojciechowski: Bermuda has created the platform to encourage governments to use risk transfer as a strategic part of their investment portfolios. The Island has worked hard to develop a world-class regulatory environment and has done this without jeopardising its reputation for innovation and bringing products quickly to market. For example, Bermuda is creating opportunities to reduce costs on the retail side that will enhance its global proposition and bring real economic value to the rest of the world in order to meet and exceed the needs of global clientele.
Bermuda has an important role in moving this agenda forward. We talk about it in terms of the protection gap. Since the BSX entered this segment of the market over 10 years ago, we have sensed an acceptance from the wider financial markets of ILS as an asset class and as a strategic part of their investment portfolio. Now, the ILS market sits at an interesting point in its existence and can encourage greater capital market participation to drive more capital to areas in the world where insurance is most needed.
Brooks: Partnerships between ILS managers and insurance companies—not just reinsurance companies—can be valuable beyond access to risk. If you want to expand the opportunity for risk transfer from the governments or individuals that are carrying it, to the broader capital markets, you need to have a front-end access point.
We always talk about being closer to the risk from the perspective of investors, but it also means insurers become closer to being able to deliver new products, and to take on additional risk at a lower cost. To the extent insurers have partnerships with ILS, that is the lowest cost form of capital available in the marketplace. If we’re going to find solutions for government-held risk, or individual-held risk, the only way to do it is through distribution combined with access to the capital.
Huff: We work with the Bermuda Monetary Authority every day, we do that because there are only two jurisdictions in the world—Bermuda and Switzerland—that are recognised by the EU and the US as being qualified jurisdictions and Solvency II equivalent. We are very well positioned to write business everywhere.
Are the rate increases that never materialised, and the reserve being worse than people thought, going to have any impact on the renewals?
Brooks: It hasn’t been uniform. In the worst case, some managers combined under-reserving with excessive rate projections. Over 2018, there has been a re-evaluation, and you’ll see this going into 2019 when ILS investors will reallocate or reconsider their preferred partners based on their ultimate performance, including reserve and rate increases.
Going forward, ILS capital levels will continue to be driven by the investors that have been more committed to the space longer-term and have more of a strategic allocation to the space. They think about having a long-term commitment to the space that flexes up or down, depending on where we are in the pricing cycle, which will dampen the future magnitude.
Gadeke: It’s tough to look ahead and not think that the amount of capacity that’s out there, the capital that’s coming in, that the momentum which came from 2017 will stay for very long. The
plus 5 to plus 7.5 that the market was getting in 2018, that dissipated pretty quickly when we went to the Florida rainy season. It’s
supply and demand, and I don’t see it lasting significantly longer through 2019.
Rhoads: The exception to that might be Florida. The original cedants in Florida, some of them did a very good job at reserving, some of them did a very poor job. I don’t think they even put that all on the ILS investors not doing the right thing, quite frankly the cedants are a lot closer to the action. At the end of the food chain is typically the ILS market, particularly the retro market.
If the front end of the market isn’t getting it right, and they didn’t get it right prior to the June 1 renewals this year, for the June 1, 2019 in Florida I would expect to see upper grade movement in that Florida business, given how the AOB issues are evolving, given how losses are evolving; for Irma there could be some advance on rates at June 1, 2019.
Brooks: That’s another reason you continue to see ILS capital pushing directly into backing insurance companies. ILS investors value an understanding of the risk and a proper evaluation after the fact as to what the loss was. From the perspective of an ILS manager who was trying to sift through a series of Florida-based insurers with different reserving practices, it was extremely challenging.
Malloy: If people walk away with a clean year in Florida, they are going to be saying, ‘so you got a little bad news from last year but, look at this, no hurricane’. We paid our freight over the last two years, so it will be interesting to see how that dialogue plays out.
Rhoads: A year ago, a lot of people were extraordinarily nervous about the future of our industry. If Irma had been a cat 4 or cat 3 going up the east coast of Florida, we would be having a very different kind of conversation, there were a lot of nervous people on that flight coming down. Two days later made a big difference when we arrived in Monte Carlo in 2017.
Gadeke: If it’s a big modelled loss, investors can rationalise it, accept it and then move on. But if they don’t expect it, if it’s really left-field—and we all speculate what a left-field loss might be—it’s difficult to put in a number on that. The one that always screams to me is California earthquake when it impacts the financial markets, as well as the reinsurance market. But outside of that, the ‘black swan’ event doesn’t seem to exist, where it’s so big and no-one saw it coming.
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